global perspectives

No central bank pivoting: time to be cautious

No central bank pivoting: time to be cautious
Philipp Burckhardt, CFA - Fixed Income Strategist and Portfolio Manager

Philipp Burckhardt, CFA

Fixed Income Strategist and Portfolio Manager
Alain Forclaz - Deputy CIO, Multi Asset

Alain Forclaz

Deputy CIO, Multi Asset
Arnaud Gernath - Co-head of Convertible Bonds

Arnaud Gernath

Co-head of Convertible Bonds
Pascal Menges - Head of Equity Investment Process and Research, Client Portfolio Manager

Pascal Menges

Head of Equity Investment Process and Research, Client Portfolio Manager
Florian Ielpo - Head of Macro, Multi Asset

Florian Ielpo

Head of Macro, Multi Asset

In the latest instalment of Simply put, where we make macro calls with a multi-asset perspective, we take stock of the Federal Reserve’s determination to bring inflation under control at the cost of economic growth and outline how this is impacting our portfolio positioning.  

 

Need to know:

  • With the Fed making clear its determination to fight inflation at all economic costs, monetary policy risk is now superseding inflation risk
  • For the moment, earnings and default risks remain under control as the economic deceleration is not pronounced enough to affect them
  • From a portfolio perspective, we are now awaiting confirmation that recession risk is rising before our cautious stance turns more defensive

 

An historic turn for the Federal Reserve

The Jackson Hole closing speech saw history being written. Federal Reserve (Fed) Chairman Jerome Powell emphasised that his “remarks will be shorter, [his] focus narrower, and [his] message more direct” than usual.

Throughout the speech, the determination of the FOMC to end the wave of inflation was made crystal clear: “The Federal Open Market Committee's (FOMC) overarching focus right now is to bring inflation back down to our 2% goal.” This will happen at the expense of the economy itself: “Reducing inflation is likely to require a sustained period of below-trend growth.” The Fed’s mandate now appears clear to all investors: the cost of capital needs to progress to bring inflation down. This is an about turn of the “whatever it takes” approach when expectations sought the first sign of a pivot; this time the Fed has not flinched.

This stance dissipates a source of uncertainty – will inflation retreat? – while creating another major risk: that of a stronger than anticipated slowdown, if not a fully-fledged recession. Figure 1 shows the historical evolution of the three largest macro risks to long-only portfolios: recession, inflation and hawkish central banks, as measured by our nowcasting indicators. This usually follows the sequence: inflation risk emerging first, monetary policy then turning extremely hawkish before a recession is triggered. Today, the message is as follows:

  • The peak for worldwide inflation is likely behind us
  • Central bank risk is clearly higher
  • Recession risk has not yet started to materialise significantly at a world level

 

FIG 1. Probability of key macro risks since 2001, measured by our growth, inflation and monetary policy nowcasters

Multi-Asset-simply-put-Key macro risks-01.svg

Source: Bloomberg, LOIM.

 

A time for caution

We currently seem to be between two risks – central bank risk and the risk of recession. This in-between situation, for investment managers, is a time for caution to resonate across all of our investment lines.  Please click on the tabs below to read how we are reacting across asset classes.

 

 

Simply put, with the Fed forcefully focusing on inflation, we see a reason for caution across asset classes which is reflected in our positioning.  

 



Macro/Nowcasting Corner

The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick. Along with it, we wrap up the macro news of the week.

Our nowcasting indicators currently point to:

  • Worldwide growth is clearly declining. The US and Eurozone are showing signs of decelerating growth momentum while the most recent data shows that this deterioration has room to go
  • Inflation surprises will remain positive for the Eurozone but are declining elsewhere and are now non-existent in the US
  • Monetary policy is set to remain on the hawkish side: central bankers are likely to be more hawkish than expected

 

World Growth Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Growth nowcaster-05Sept-01.svg

 

World Inflation Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Inflation nowcaster-05Sept-01.svg

 

World Monetary Policy Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Monetary Policy nowcaster-05Sept-01.svg

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

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